Advertisement

Journal of Business Ethics

, Volume 80, Issue 1, pp 37–44 | Cite as

Does Payment For Order Flow To Your Broker Help Or Hurt You?

  • Robert H. BattalioEmail author
  • Tim Loughran
Article

Abstract

The presumption is that a broker executing a stock trade for a retail investor will get the investor the best possible price execution for the transaction. In fact, the broker often sells the retail investor’s trade to an intermediary for cash payment. The broker’s motivation to generate dealer profits seems to overcome the broker’s fiduciary responsibility to obtain the best execution price for the customer, raising ethical questions. Purchasers and internalizers of order flow in the market may cause prices quoted on the NYSE to deteriorate, making all investors worse off.

Keywords

Payment for order flow Madoff Broker execution Internalization 

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

Notes

Acknowledgements

We would like to thank participants at the 2006 University of Notre Dame Ethical Dimensions in Business Conference, a referee, and Ann Tenbrunsel (editor) for helpful suggestions. Kim Lorenzen provided helpful research assistance.

References

  1. Ackermann C., T. Loughran 2007, Mutual Fund Incubation and the Role of the Securities and Exchange Commission, Journal of Business Ethics 70, 33–37CrossRefGoogle Scholar
  2. Battalio R. 1997, Third Market Broker-Dealers: Cost Competitors or Cream Skimmers? Journal of Finance 52:341–352CrossRefGoogle Scholar
  3. Battalio R., J. Greene R. Jennings, 1998, Order Flow Distribution, Bid-Ask Spreads, and Liquidity Costs: Merrill Lynch’s Decision to Crease Routinely Routing Orders to Regional Stock Exchanges, Journal of Financial Intermediation 7, 338–358CrossRefGoogle Scholar
  4. Battalio R., R. Jennings J. Selway, 2001 The Relationship Among Market-Making Revenue, Payment for Order Flow, and Trading Costs for Market Orders Journal of Financial Services Research 19, 39–56CrossRefGoogle Scholar
  5. Boehmer, E., R. Jennings and L. Wei: 2007, ‹Public Disclosure and Private Decisions: Equity Market Execution Quality and Order Routing,’ Review of Financial Studies 20, 316–358Google Scholar
  6. Chen H.-C., J. Ritter 2000 The Seven Percent Solution Journal of Finance 55, 1105–1131CrossRefGoogle Scholar
  7. Doyle, J. M.: 1993, ‹Paying for Stock Orders: Bribery or Competitive Edge?’ (The Associated Press, 16 May)Google Scholar
  8. Houge T., J. Wellman 2005, Fallout from the Mutual Fund Trading Scandal Journal of Business Ethics 62, 129–139CrossRefGoogle Scholar
  9. ‹How Street Turns Trades into Gold.’ Wall Street Journal 16 February, 1993Google Scholar
  10. Loughran T. 2005, NASD Rule 2110 and the VA Linux IPO, Journal of Business Ethics 62, 141–146CrossRefGoogle Scholar
  11. Macey J., M. O’Hara 1997, The Law and Economics of Best Execution Journal of Financial Intermediation 6, 188–223CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media B.V. 2007

Authors and Affiliations

  1. 1.Mendoza College of BusinessUniversity of Notre DameNotre DameU.S.A.

Personalised recommendations